What sets dynamic equity funds apart

ET Bureau|

Mar 08, 2018, 07.56 AM IST

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Broad indices also continue to trade at a premium to long term average valuations.

There is much talk of a recovery in corporate earnings. Broad indices also continue to trade at a premium to long term average valuations. Given these conditions, many wealth managers believe dynamic equity funds are a good bet.

1. How is a dynamic equity fund different from a diversified fund?

Most diversified equity mutual fund schemes are fully invested in stocks as per their mandate and do not take any cash calls. Dynamic equity funds invest in a mix of debt and equity. They increase/ decrease their allocation to equities and debt depending on their view of the stock markets. Typically, when stock markets fall they increase equity in the portfolio and when they are up they reduce it. The equity component of the portfolio would vary depending on the method of calculation used by the fund house. A fund house is free to use its own methodology for calculation this. A fund could use the Nifty PE, price-to-book value or any other inhouse proprietory models to allocate.

2. Why do many financial planners recommend these to first-time equity investors?

Many first-time equity investors are not used to volatility in the equity markets. They are moving money from fixed deposits to equities. In case the markets were to correct, a portfolio with a mix of debt and equity would face lower volatility than a pure equity fund portfolio. This would give them a better experience instead of diversified equity funds, believe financial planners.

3. What are the pros and cons of such funds?

Dynamic equity funds automatically rebalance portfolios and hence it is recommended for first-time equity investors. If the market was to enter a corrective mode, dynamic funds with a lower allocation to equities could see a lower erosion in their net asset value (NAV) as compared to a pure equity fund. Since dynamic equity funds tend to hold higher debt when equities surge in prolonged rallies as we saw in 2017, they could underperform diversified equity MFs. Essentially, lower volatility could end up giving lower returns in prolonged bull markets.

4. How are these funds treated from a taxation perspective?

One huge advantage of these dynamic funds is that they are structured in such a way that they are taxed as equity funds for investors. Most funds when they lower their exposure to equities, ensure that the equity plus arbitrage component of the scheme is at least 65 per cent of the corpus, which helps it qualify for equity taxation. As per the new tax laws from the next financial year, investors will have to pay as much as 10 per cent long-term capital gains tax if they sell their units after holding them for one year.